The importance of ‘nudge’ theory for value investors

Value investors should look to the work of Nobel Prize winner Prof Richard Thaler for insight into behavioural finance

We’ve frequently written about Prof Richard Thaler, an expert in behavioural finance, on our investment blog The Value Perspective. His thinking can help you become a better investor.

We were delighted to see him awarded the Nobel Prize in economics this month. And his views should matter to you as a citizen. He developed the theory of “nudge”, where rules, structures or incentives are subtly tweaked to achieve a better outcome for those being nudged. It helped to bring “auto-enrolled” pensions to the UK, for example. Millions more people are now saving for retirement as a result.

His views should also matter to you as an investor. His books, including Nudge (2008), have established that humans often make irrational decisions. Once you accept this, you can become a better investor. Instead of listening to a company “story”, you pay more heed to the facts and to the numbers.

“The disciplined value investor ignores these “stories” to focus on the facts”

This is value investing – a discipline our team patiently follows. You buy stocks substantially below their intrinsic value and avoid those exceeding it. Inevitably you exploit the irrationality and emotions of others.

Prof Thaler’s work echoes that of Benjamin Graham, the godfather of value investing, who warned in 1949 that stocks could be ignored through “neglect or prejudice”. Stocks in that camp today include unloved companies such as banks and retailers.

One investor might say retail is an industry being killed by online shopping. Another might argue that bricks-and-mortar chains are reinventing themselves as shopping experiences with a glowing future.

The disciplined value investor ignores these “stories” to focus on the facts. Plenty of evidence has shown this approach to work over long spells, so surely investors would all do it this way? They don’t. Investors, after all, are irrational.

Please remember that past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.

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